IRR - Modest Depreciation Ahead

BMI View: The Iranian rial will undergo renewed depreciation in the coming quarters after a period of relative stability following the unification of exchange rates. We forecast depreciation of between 5-10% against the US dollar over the coming years, which is broadly in line with the inflation differential. This contrasts starkly with the rapid depreciation seen over the past five years, with the nuclear deal, much lower inflation, and an improving economy mitigating some of the forces to the downside.

Short-Term Outlook (three-to-six months)

The Iranian rial will undergo a further bout of depreciation in H217, having enjoyed a period of relative stabilisation on the official market since the end of 2016. At present we believe there is significant political influence to ensure the currency does not significantly weaken (which would result in inflationary pressures) before the Presidential election in May 2017. From Q317 we expect a gradual depreciation in the currency against the dollar in line with high inflation rates compared with the US. Indeed, depreciatory pressures are evidenced by the divergence between the official rate at IRR32,500/USD and the black market rate at IR39,100/USD (as of the start of April). We believe the black market rate has fallen partly due to concerns over the election of Donald Trump and partly due to concerns over the sustainability of the nuclear deal. We expect the nuclear deal to remain intact, but for the key driver of depreciatory pressures to be relatively high inflation over the coming months.

Stready Depreciation Coming, But Devalutions Have Passed
Iran - IRR/USD, Exchange Rate
e/f = BMI estimate/forecast. Source: BMI, national sources

IRR - Modest Depreciation Ahead

BMI View: The Iranian rial will undergo renewed depreciation in the coming quarters after a period of relative stability following the unification of exchange rates. We forecast depreciation of between 5-10% against the US dollar over the coming years, which is broadly in line with the inflation differential. This contrasts starkly with the rapid depreciation seen over the past five years, with the nuclear deal, much lower inflation, and an improving economy mitigating some of the forces to the downside.

BMI Iran Currency Forecast
Spot 2017 2018
Source: BMI, Bloomberg. Last updated: April 3 2017
IRR/USD, ave 32,425 34,000 38,000
IRR/EUR, ave 34,628 35,020 38,760

Short-Term Outlook (three-to-six months)

The Iranian rial will undergo a further bout of depreciation in H217, having enjoyed a period of relative stabilisation on the official market since the end of 2016. At present we believe there is significant political influence to ensure the currency does not significantly weaken (which would result in inflationary pressures) before the Presidential election in May 2017. From Q317 we expect a gradual depreciation in the currency against the dollar in line with high inflation rates compared with the US. Indeed, depreciatory pressures are evidenced by the divergence between the official rate at IRR32,500/USD and the black market rate at IR39,100/USD (as of the start of April). We believe the black market rate has fallen partly due to concerns over the election of Donald Trump and partly due to concerns over the sustainability of the nuclear deal. We expect the nuclear deal to remain intact, but for the key driver of depreciatory pressures to be relatively high inflation over the coming months.

Stready Depreciation Coming, But Devalutions Have Passed
Iran - IRR/USD, Exchange Rate
e/f = BMI estimate/forecast. Source: BMI, national sources

We expect the central bank to step into the foreign exchange market to help stabilise the value of the currency, especially given expected investment into the country. Although the economy's balance of payments position remains on a less than firm footing, the authorities should still possess a sufficient financial arsenal to use in their defence of the rial. According to the latest data from the IMF, foreign reserves currently sit at approximately USD111bn, which is equivalent to 12 months of imports.

Long-Term Outlook (six-to-24 months)

Improvement in the macroeconomic situation will lead to increasing confidence in the currency among traders. We forecast real GDP growth of 5.0% and 4.7% in 2017 and 2018, respectively, driven by improved investor and consumer confidence, more effective macroeconomic management and low base effects. Importantly, recent consumer price index (CPI) readings point to a gradual decline in price pressures, which have been a major driver of currency depreciation in recent years. CPI came in at 9.4% y-o-y in October (the latest figure available), one of the lowest levels for 25 years, and we expect headline inflation to moderate over the coming quarters.

Reduced Depreciatory Pressure
Iran - Real Effective Exchange Rate
Note: REER rebased to 100 from 1979. Source: IMF, BMI, Bloomberg

Iran's real effective exchange rate (REER) index has ticked up 109 in February, indicating a slight overvaluation against the currencies of its trading partners. The government is trying to bolster non-oil exports, but structural issues such as lack of access to financing remain an impediment, rather than the currency. A weaker currency would assist the fiscal position (by enlarging oil sales in local currency terms) and make Iran more attractive for investment.

Risks To Outlook

Risks are weighted to the downside, with the possibility of depreciation, particularly if there was a breakdown in the nuclear deal (the risk of which has increased given President Donald Trump's rhetoric against Iran) or a sudden uptick in inflation due to subsidy cuts. Furthermore, the central bank and government may decide that foreign reserves are best suited to spending on dilapidated infrastructure or public services rather than supporting the currency at an overvalued level.

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